Promoting Socially Efficient Outcomes Through Green Taxes

June 30, 2017 | By Clara Cecil

A market economy promotes economic efficiency, encourages competition, and matches supply and demand. However, a chief failure of markets is their inability to account for the social and environmental costs of doing business. In a world where legislation often appears to the business world as an irritating obstacle to efficiency, what if policy had the potential to act as a tool for efficiently correcting for the market’s failures? In an era where tax codes appear outdated and citizens are skeptical about what happens to their hard-earned tax dollars, what if tax policy had the potential to encourage changes in behavior and to innovatively drive social change?

Enter green taxes. Unlike the free market, this type of policy instrument recognizes the social and environmental costs of a polluter’s actions and redirects the collected funds towards problem resolution. In the current system, businesses have an economic incentive to exploit individuals, communities, and the environment to match supply with demand at the cheapest price. By taxing environmentally harmful practices in a way that mirrors the cost of the damage, green taxes counter the economic incentive to produce cheaply without regard for the social and environmental consequences.

Green taxes provide the opportunity not only to combat climate change but also to insert transparency into the complicated tax code system and to collect additional tax revenue without raising income or sales tax. Furthermore, green tax revenue can be strategically applied to aid those who are most negatively impacted by the transition from traditional power sources to clean energy, such as coal mining communities. Green taxes permit more informed consumer decision making, as prices more accurately reflect all of the costs of production. When implemented strategically, this policy instrument creates a sense of urgency to regain economic efficiency through innovation.

Despite these benefits, green taxes present undeniable challenges. First, the process of implementing the tax and assigning monetary values to various types of emissions is complex, uncertain, and expensive. There are also potential unintended consequences of green tax implementation, such as firms electing to pay small-enough green taxes while continuing to disregard environmental outcomes. In the absence of comparable policies across all economies, there is an incentive for firms to simply shift to cheaper production overseas. Tax evasion and covert operations remain other possible undesirable consequences of implementing green taxes.

In order to effectively implement green taxes, a government should set up a gradual tax increase, allowing time for planning and innovation to occur before price increases become unmanageable. The tax itself should be high enough to cause a shift in behavior but also low enough to avoid economic turmoil — a compromise requiring extensive research and investment. Beginning in 2008, British Columbia implemented the only successful large-scale carbon tax in North America. Although British Columbia’s green tax was not a perfect representation of the cost of carbon pollution, the province chose an arbitrary, modest tax per ton of emission and reduced emissions seven times faster than previously projected. The example of British Columbia demonstrates that a green tax is a transparent price signal that can lead to more responsible investments and can ignite an economy-wide commitment to eco-efficiency without resulting in economic collapse. Imports of energy-intensive products from the United States increased significantly following the introduction of the carbon tax, showing that British Columbia’s tax implementation could have been even more successful in the presence of international collaboration. Nonetheless, British Columbia’s green tax proved to be a collaborative issue with bipartisan support, serving as a model for countries to implement similar taxes in the future.

While green taxes are emerging as a promising form of policy innovation, there remains a role for traditional regulation in setting emissions standards to meet the goals set forth internally by governments and externally by international climate agreements. Although green taxes primarily refer to taxes on emissions, there is potential for future expansion of the tax mechanism to other socially harmful practices. Requiring the strategic collaboration of government, nonprofit, and for-profit entities, green taxes prove to be an effective tool for encouraging socially, environmentally, and economically efficient outcomes.

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